- with readers working within the Banking & Credit industries
The existing income sourcing rules do not currently address the source of "borrow fees," i.e., fees paid by securities borrowers to securities lenders in securities lending transactions. In a move that could provide significant clarity to foreign securities lenders, the IRS recently published Notice 2025-63 (the "Notice"), announcing its plans to issue proposed regulations that would source borrow fees under market standard agreements according to the recipient's residence. By sourcing borrow fees according to the recipient's residence, non-U.S. securities lenders, such as foreign hedge funds, would generally not be subject to U.S. withholding tax on their borrow fees.
The proposed regulations would address borrow fees paid on securities lending transactions documented pursuant to standardized master agreements, e.g., MSLAs and GMSLAs. Under those agreements, the borrow fees in securities lending transactions can take various forms depending on the collateral type and market conditions. If a securities borrower posts non-cash collateral, the securities borrower typically pays the securities lender an explicit borrow fee. If the securities borrower instead posts cash collateral, the securities lender typically invests the cash, pays a rebate to the securities borrower, and retains the excess earned on the cash, which excess is economically equivalent to a borrow fee. However, market conditions such as low interest rates or high demand for specific securities may limit the securities lender's ability to generate the economic equivalent of a borrow fee on its cash collateral. In those instances, the securities borrower may instead pay a "negative" rebate to the securities lender to compensate the securities lender for the shortfall. The proposed regulations would source both borrow fees and negative rebates according to the recipient's residence.
Additionally, the proposed regulations would address negative rebates under standardized sale repurchase agreements ("repos"), e.g., MRAs under which the repo buyer purchases securities from the repo seller for cash, subject to the repo seller's agreement to repurchase the securities at a future date. Similar to standardized securities lending transactions, the repo buyer may also be required to pay the repo seller a negative rebate if market conditions prevent the repo seller from earning the economic equivalent of a borrow fee. The proposed regulations would also source this negative rebate according to the recipient's residence.
Taxpayers may immediately rely on the Notice with respect to securities lending transactions and sale repurchase transactions addressed thereby and will be able to prospectively rely on the forthcoming proposed regulations for taxable years following their publication.
Importantly, the Notice clarifies that the substance of the fee, rather than its label as a borrow fee or negative rebate, is the determinative factor in sourcing the fee income.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
